This fund is currently allocated 47% in a TIPS index, 30% in a REIT index, and 23% in the DJ AIG Commodity index. The real asset return fund was up 3.75% through the first quarter of 2011 and 16.6% over the last year.

Unfortunately, the real asset return fund in our 401k plan has an expense ratio of 0.80%. It’s not awful but still more than I am used to paying for our Vanguard index funds and ETFs.

Do any of you invest in a real asset return fund? Do you even have that option inside your retirement plan?

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Since we purchased the new exchange traded funds (EFTs) in our portfolio in July, they have increased in value: BWX (+ 14.4%),  VEU (+ 14.4%), VTI (+ 9.12%), and BSV (+1.51%).  Our other major 401k holding is VIPSX. It is up 6.07% but because it is a mutual fund, I cannot set a stop loss order on that position.

Based on these gains over a three-month period, it was time to adjust the stop loss price upward, except for the BSV position. I decided to set the new stop loss sell points at prices representing what I would consider an intolerable short-term loss from our current positions, taking into account the volatility of each particular ETF. The market would have to drop approximately 7%-8% to hit my new stop loss points. That could happen on some very bad news or based on another episode of programmed selling gone awry. If the ETFs sold at the stop loss price points, I still would have locked in gains from our purchase price. I could reenter the market when whatever conditions created the sudden volatility disappeared.

Some might call what I am doing as an attempt to time the market. I don’t look at it that way because I am not getting in and out based on gut reactions or technical analysis. I am simply trying to manage our risk and prevent another double digit loss in the value of our portfolio. I am too close to retirement not to do that.

What are you doing to manage risk in your retirement portfolio?

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First, I am very concerned about another significant and extended market decline. We cannot tolerate that. In fact, I expected the market to drop today and it happened. Therefore, I want to move most of our mutual fund holdings into ETF’s so that I can use stop loss orders. (You cannot place a trading day “stop loss” order on a mutual fund.)  That part is done.

Second, I have decided to transition from the “10 Speed” variety of couch potato portfolio to the “Four Square” couch potato allocation. This will reduce our 401(k) holdings from ten to four, making it easier for me to manage risk inside our self-managed brokerage account. It will also substantially reduce the percentage of equity holdings in the portfolio and therefore our market risk going forward.

Finally, our 401(k) account holdings were due for a re-balancing anyway so it made sense to accomplish all of this at the same time.

After the dust settles, I expect that our asset allocation in our 401(k) account will look like this: 25% in VIPSX, 25% in Vanguard’s Total (U.S.) Stock Market ETF (VTI), 25% in Vanguard’s All-World (except U.S.) Stock Market ETF (VEU), and 25% in BWX (an international treasury bond index ETF). We already own the VIPSX and BWX.

I also have some cash accumulated in our 401(k) account that I am using to buy TIPS for the guaranteed income portion of our retirement plan.

At first I was hesitant to eliminate certain assets, such as our REIT index fund. But we own plenty of residential real estate now (with more to come) so lowering our ETF exposure in that category doesn’t bother me.

Are you making any changes to your retirement investments?

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1. Reallocating to a Real Asset Return Fund

According to this article from Investment News, Putnam investments is introducing a new simplified retirement income calculator for its 401(k) plan participants. The most important feature of this new calculator is that every time a plan participant logs in to his or her account, they will see their account balance expressed as retirement income.

In my opinion, every 401(k) plan participant should not only have easy access to that retirement income prediction, they should be forced to look at it regularly. The calculation and display of the retirement income prediction should be automatic. Isn’t seeing the reality of what income your account balance may provide the best way to motivate a baby boomer to save more for retirement?

Watching an account grow (hopefully) is all well and good but not if the end-game leads to an inadequate retirement income, even when combined with Social Security benefits. If you see a 401(k) balance of $100,000 at age 58 you might think “I’m doing great.” If you see that your predicted lifetime income from that plan balance is $350/month, your level of contentment may change.

I receive similar income prediction information now from my 401(k) plan provider, but I have to use an optional retirement planning tool the plan offers to obtain it. Most people don’t take the time to use that tool. It takes work and it can be intimidating.

I hope that Congress amends ERISA or that the Department of Labor adopts rules that require all 401(k) plan providers to deliver realistic retirement income predictions to plan participants. Meanwhile, you should ask about this feature at work and agitate a little to obtain it. I’ve done that in the past for other aspects of our 401(k) plan, including increasing the diversity of investment offerings.

Remember, it’s not the size of the nest egg. It’s the retirement income that nest egg will provide.

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1. Get a Lifetime Investment Income From Your Retirement Portfolio

Here is the 2010 contribution limit data, courtesy of the IRS:

2010 401(k)/403(b) Contribution Limits :

After many expressed concern that the 2010 401(k) contribution limits would be decreased, the IRS has announced that they will remain the same as 2009: $16,500 plus a $5,500 catch-up contribution if you are 50 or over, for a total of $22,000.

For all of the exciting details, consult this IRS press release and this IRS 401(k) Resource Guide.

2010 IRA Contribution Limits:

If you are under 50 years of age at the end of 2009, the maximum contribution that you can make to a traditional or Roth IRA is the smaller of $5,000 or the amount of your taxable compensation for 2009. This limit can be split between a traditional and a Roth IRA but the combined limit is $5,000. The maximum contribution to a Roth IRA and the maximum deductible contribution to a traditional IRA may be reduced depending upon your modified adjusted gross income (modified AGI).

If you are 50 years of age or older before 2010, the maximum contribution that can be made to a traditional or Roth IRA is the smaller of $6,000 or the amount of your taxable compensation for 2009. This limit can be split between a traditional and a Roth IRA but the combined limit is $6,000. The maximum contribution to a Roth IRA and the maximum deductible contribution to a traditional IRA may be reduced depending upon your modified AGI.

To determine if and how much of your traditional IRA contributions will be deductible in 2010 based on your income and marital status, use this IRS table if you have a retirement plan at work, and this IRS table if you do not. Roth IRA contributions, of course, are not tax deductible.

2010 HSA Contribution Limits:

Health Savings Account (HSA) participants can contribute up to $3,050 for an individual and $6,150 for a family plan. Participants 55 and older can contribute an extra $1,000, or $4,050 for an individual account and $7,150 for a family account.  These contributions are 100% tax deductible from gross income. The limits apply to the combination of employee and employer contributions to the account.

Being able to sock away $7150 annually tax-free, and being able to withdraw it (and earnings) in retirement tax-free is a fantastic deal. I sure hope Obamacare doesn’t change this.

Minimum annual deductibles for HSAs in 2010 are $1,200 for self-only coverage and $2,400 for family coverage.

Annual out-of-pocket expenses (deductibles, co-payments and other amounts, but not premiums) cannot exceed $5,950 for individual coverage and $11,900 for family coverage.

Don’t forget that you have until you file your 2009 federal income tax return to complete your 2009 IRA and 401(k) contributions!

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1. Should You Undo Your 2010 Roth IRA Conversion?

Stop cashing out those 401(k) accounts!

According to a recent survey by Hewitt Associates, 46% of those persons who changed jobs or lost their jobs in 2008 took the cash out of their 401(k) accounts. Even for those in the age groups 40-49 and 50-59, the cash-out rates were 43% and 34% respectively. That is a terrible statistic. Yes I know that they think they need the money then, but not as much as they will need the money when they retire. This sad trend by the way did not begin with the current economic crisis. The cash-out data has remained stable since 2005.

Baby boomers (ages 55-64) have been doing an awful job of exploiting tax-advantaged retirement plans. In fact, a study done by the Boston College Center for Retirement Research showed that 401(k) and IRA accounts represent just 7%  of their retirement wealth. This compares to 20% represented by the value of their primary residence. Of course, that data is from 2007 and we know what has happened to real estate values since then.

The knee-jerk reaction to this information is to blame the 401(k) plan for the early withdrawals. I disagree. The real problem is lack of financial discipline. Too many folks treat their retirement accounts as a “rainy day” fund. They use their departure from one employer – even just to take another job – as an excuse to raid their 401(k) account. Unless they have reached the magic age of 59 1/2, the 10% early withdrawal penalty and taxes will take a huge bite out of that money.

Baby boomers who withdrew 401(k) cash (or stopped contributing) also suffered by losing out on the stock market rebound since March 2009. This data from the Employee Benefit Research Institute show declining average 401(k) balances for many folks in the 45-54 and 55-64 age groups since January 2008 whereas the accounts of younger employees did much better.

What are folks doing with this 401(k) cash out money?  An earlier study by the Employee Benefit Research Institute found that while many just “spent it” , even more used it to pay down debt, buy a house, or start a business. These don’t sound like hardship withdrawals to me.

I suppose from these numbers you could conclude that there is at least one thing wrong with 401(k) plans. They make it too easy for employees to get at their accounts before they retire.

Think about this before cashing out that 401(k) account fellow baby boomers: The pain of financial discipline is much less than the pain of retirement (or unretirement) regret.

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A required minimum distribution is the smallest annual amount that must be withdrawn from an IRA or 401(k) beginning in the year that the account owner reaches age 70½. The 2008 law waives required minimum distributions (RMD) for 2009 for IRAs and 401(k)s). It also allows certain amounts distributed as 2009 required minimum distributions to be rolled over into an IRA or another retirement plan.

When the law was first passed, an account owner who had already received an RMD was allowed 60 days after receiving the money to put it back into the retirement account. The IRA has now extended that deadline until the later of November 30, 2009 or 60 days from the time you withdraw the money. This is good news for retirees to be sure.

1. You are allowed to return only one IRA withdrawal back into the account within a 365 day period. This means that if you received regular distributions every month, you can return only one of those withdrawals. However, if you received the RMD in a lump sum, you can put it all back into the account.

2. If any taxes were withheld from your RMD, that money needs to be returned also. If it is not, the amount withheld for taxes will be considered a distribution and will be taxed as ordinary income.

3. Since you didn’t have to take an RMD in 2009, that leaves more IRA money available for possible conversion to a Roth IRA.  Although you will pay taxes when you make the switch, you can take tax-free withdrawals after five years. The Roth conversion also means no more required minimum distributions and a potential a tax-free inheritance for your heirs. If you want to make the conversion in 2009, your adjusted gross income just needs to be below $100,000. That income limit is removed in 2010.

4. If you notified your IRA or 401(k) account service to stop RMD withdrawals in 2009, be sure to restart them in 2010 to avoid being penalized.

For more information on the RMD payback extension, you can read IRS Notice 2009-82.

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401(k) Plan Hardship Withdrawals

How do these retirement plan leaks occur? The most common scenario is a hardship withdrawal. These early withdrawals are permitted in some circumstances, such as to cover un-reimbursed medical expenses, to purchase a principal residence,  to pay certain education expenses, for payments necessary to prevent eviction or foreclosure, funeral expenses, and certain expenses for the repair of damage to your principal residence.

An “early withdrawal” is one that occurs before the plan participant reaches age 59 and 1/2.

However, a hardship withdrawal from a 401(k) account can still trigger a 10% penalty plus taxes owed, unless you are:

• Totally disabled
• Your unpaid medical expenses exceed 7.5 percent of your adjusted gross income.
• You are required by court order to give the money to a divorced spouse, a child, or a dependent.
• You leave your job due to layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.

According to a recent GAO Report, an early withdrawal or complete retirement plan cash-out of this nature at job separation is terribly damaging to your retirement future:

Participants who voluntarily cashed out their entire 401(k) account balance at job separation experienced the largest reductions in the amount of retirement savings that accumulate over their working careers,” the report noted.

For example, a participant who cashed out his entire 401(k) at age 35 would forfeit more than $183,000 in savings by his 65th birthday, according to the report. Cashing out later in a career, when there is less time to recover from losses, leaves an even bigger wealth gap.

I couldn’t have said it better myself.

One aspect of a 401(k) hardship withdrawal that many folks don’t consider is that the person making the withdrawal is prohibited from making more contributions to his or her 401k account for six months after the withdrawal. This prohibition also includes employer contributions.

I think that anyone over the age of 50 who proposes to cash out or take a hardship withdrawal from a retirement account should receive mandatory counseling from a financial advisor.

IRA Hardship Withdrawals

The rules for hardship withdrawals from an IRA are somewhat different. Also, traditional and Roth IRAs have different rules.

An IRA owner can make no-penalty hardship withdrawals for:

• Excessive un-reimbursed medical expenses.
• Payment of medical insurance premiums while unemployed.
• Total and permanent disability.
• Distribution of account assets to a beneficiary after you die.
• Certain qualified educational expenses.
• First time home purchases (maximum of $10,000 per purchaser)

If this is a conventional IRA, you still must pay taxes on the withdrawals.

Finally, the IRS will allow early withdrawals from an IRA without penalty based on the “substantially equal periodic payment rule.” Using this method, you must distribute the entire IRA balance using equal payments spread over your life expectancy.

The bottom line is that baby boomers should consider an early hardship withdrawal from a retirement account only as an absolute last resort.

Photo credit: The Pageman

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Judgment Creditors and Retirement Accounts

In this issue, I am not referring so much to mortgage lenders and credit card companies. They need to be paid. I am speaking more about the unexpected creditor, such as someone who comes after you for an overwhelming and uninsured medical expense or lawsuit judgment. The concern is greatest if such a judgment forces you into bankruptcy.

The first issue that comes to mind is protection of retirement assets of one spouse from the creditors of the other spouse. This will depend in large part on how the asset is owned. 401(k) and IRA accounts are not jointly owned but they do have beneficiaries. Generally, a creditor of a non-owner spouse has no rights to pursue that asset except if the owner spouse dies while the account is still in place. Then it gets more complicated.

Federal and State Protection of Retirement Assets

Funds held in 401(k) plans are shielded from all creditors by the federal Employee Retirement Income Security Act (ERISA). No federal or state court creditor can touch 401(k) money except for claims made by a spouse or by the IRS. 

Funds held in an IRA are not protected by ERISA. However, the 2005 bankruptcy reform legislation provides protection for up to $1 million in IRA funds that you contributed, including Roth IRAs. This makes it even more important to keep good records of your IRA contributions.

SEP, Simple IRAs, Keogh, and solo 401(k) plans are completely exempt (with no upper limit) from bankruptcy proceedings, as are IRAs that are rolled over from a 401(k) or other qualified retirement plan.

Outside of federal protection, the ability of creditors to go after IRA funds in or outside of bankruptcy is determined by state law. Some states  (New York, New Jersey and Connecticut for example) will protect all IRA funds while other states will cap that protection at $100k or $500k.

Still other states – California being a prominent example – protect only those IRA and other retirement assets that are “reasonably necessary” to support the owner of the funds and dependents. This is a flexible test that depends on the owner’s income, age, and other assets.

Final Thoughts on Creditors and Retirement Accounts

Anyone who works in a field that is high risk for uninsured attacks by judgment creditors needs to be careful about how retirement assets are held. For example, rolling over a 401(k) account to an IRA may not be the best idea in some states, because of possible loss of protection from creditors.

Similar concerns can arise if a retiree is offered a choice of receiving a pension benefit in a lump sum.

Bottom line: Get some legal advice from a lawyer in your state about protecting retirement assets before you make a financial planning decision that is irrevocable.

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Also, even if you specify in your will how your retirement plan benefits are to be distributed, your will cannot override a beneficiary designation in the plan documents themselves. 

So what retirement plan documents should baby boomers be reviewing?

Primary beneficiary designations on qualified defined contribution plans.

These include 401(k), 403(b), SEP, and similar plans. (Note that a spouse must generally provide written consent if you attempt to remove him/her as primary beneficiary on a qualified defined contribution plan.)

Primary beneficiary designations in qualified defined benefit (pension) plans.

Again, you will generally have to obtain spousal consent to name someone other than your spouse.

Contingent beneficiary designations in qualified defined benefit and contribution plans.

A contingent beneficiary is named to cover circumstances where your primary beneficiary pre-deceases you or dies in a joint accident with you.   When boomers were younger, they would often designate minor children (or a trust for minor children) as a contingent beneficiary.  If the children are now grown up, you will probably want to change your contingent beneficiary, perhaps by naming your estate.  That way, your will can be used to determine where your retirement benefits will go upon your death.

Primary and contingent beneficiary designations for IRA balances.

The rules for rolling over an inherited IRA vary depending on whether the beneficiary is or is not a spouse.  The status of the beneficiary can also affect the application of required minimum distribution rules.  Thus, baby boomers should carefully consider their options when updating designations of IRA beneficiaries.  For more guidance on this issue, consult IRS Publication 590.  

Secondary/joint owners of bonds and CD’s set aside for retirement.

Most issuers of bonds and CD’s allow you to designate a secondary or joint owner of those financial instruments.  This is true for I-Bonds, for example.  If you have some of these assets in your retirement nest egg, you should review those designations to make sure they reflect your current family status.   Generally, there is no need to obtain the consent of any existing beneficiary to make these changes.

I like to review the beneficiary status for our retirement plans each year when I am working on our income tax returns.  This is a convenient reminder for me.  Perhaps that would make sense for you as well.

Image credit:  Kriss Szkurlatowski

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